Does Interest Expense Go Above or Below the Operating Income Line?

For most companies, interest expense is not an operating expense. GAAP classifies it below the operating income line in the "Other Income/Expense" section, outside of both EBIT and EBITDA. A single misclassification makes operating income look weaker than it is, and every metric or covenant calculation built on those numbers inherits the error.

In this guide, we explore why GAAP draws that line, the practical differences between interest and operating costs, and how to get the classification right in your accounting setup.

In brief:

• Interest expense is a non-operating expense under GAAP for most businesses. It sits below operating income on the income statement, outside of EBIT and EBITDA.
• Operating expenses cover day-to-day costs (salaries, rent, COGS). Interest expense reflects a financing decision, not an operational one.
• Booking interest inside operating expenses understates EBIT and makes lender-facing metrics like the interest coverage ratio harder to calculate accurately.
• Getting the chart of accounts right from the start prevents a chain of downstream errors in financial reporting and covenant compliance.
• Automation platforms can flag misclassified interest charges, post accruals automatically, and generate reports where EBIT and non-operating items are already separated.

What are the key differences between interest expense and operating expense?

Interest expense is classified as a non-operating expense under US GAAP for most companies, meaning it is reported below operating income rather than within it. Operating expenses cover the day-to-day costs of running the business: salaries, rent, software subscriptions, and cost of goods sold. Interest expense reflects a financing decision, not an operational one.

Here are the differences that show up most often for finance teams reviewing an income statement:

For a staffing firm, a SaaS company, or a distribution business, borrowing money is not the core activity. The interest paid on a bank loan or line of credit is the cost of capital, not the cost of serving customers, so GAAP places it below operating income on the P&L.

Financial institutions are the exception, since lending is their primary business.

Each of those differences has practical implications for how you record transactions, how lenders read your financials, and how coverage ratios hold up under scrutiny.

Income statement placement

Operating expenses appear above the operating income line on a multi-step income statement, directly reducing EBIT. Interest expense sits below that line in the "Other Income/Expense" section.

Booking interest above the line makes operating income look worse than it actually is, and every metric built on EBIT inherits that error.

What each category reflects about your business

Operating expenses reflect the costs of delivering your product or service to customers. Interest expense reflects the terms of your debt agreements. Two companies with identical revenue and headcount could show very different interest expense depending on whether one borrowed to grow and the other did not.

Separating these gives anyone reading your financials a cleaner view of operational performance.

How interest expense affects key financial metrics

EBIT and EBITDA both exclude interest expense. When interest gets booked inside operating expenses, both metrics come out wrong. The interest coverage ratio, which lenders embed in loan covenants, also becomes harder to calculate accurately.

One chart-of-accounts mistake can create a chain of downstream errors across every metric tied to operating income.

Who controls the cost?

The operations team controls operating expenses through vendor negotiations, hiring decisions, and procurement choices. Financing decisions drive interest expense: how much debt your company carries, the rate you negotiated, and the repayment term.

Keeping them separate clarifies accountability and makes it easier to assess whether a cost problem lives in operations or on the balance sheet.

Tax treatment differences

Both operating expenses and interest expense are generally tax-deductible, but interest expense has its own rules under Section 163(j). Companies above the $31 million average annual gross receipts threshold face a cap on the amount of business interest they can deduct in a given year.

Operating expenses don't carry an equivalent limitation, and the difference affects how lenders evaluate creditworthiness and how buyers price a business. Getting the classification right from the start prevents the downstream problems those differences can create.

Best practices for managing interest expense as a non-operating expense

We recommend starting with a few specific steps in your accounting software and monthly close process. Each one addresses a recurring source of bookkeeping mistakes that go unnoticed until a lender review or audit surfaces them.

1. Set up the chart of accounts correctly from the start

Choosing the wrong account type for interest accounts embeds them inside operating costs on the P&L, and most accounting systems won't flag the misclassification automatically.

The setup varies slightly across the three most common platforms:

• QuickBooks: Select "Other Expense" as the account type and number accounts in the 8000 range to keep them separate from operating expenses in the 6000 to 6999 range.
• NetSuite: Use the "Other Expense" account type. NetSuite's native P&L automatically places interest below operating income.
• Xero: Since Xero doesn't offer a separate "Other Expense" type, use tracking categories to filter interest out of operating expense reports.

Once your account types are set, the next step is to record each loan payment correctly.

2. Split every loan payment between principal and interest

Recording the full monthly loan payment as a single expense is a common booking error, and the distortion grows every month it goes uncorrected. Only the interest portion of any loan payment is an expense.

The principal portion reduces the balance sheet liability and should never appear on the income statement. Your lender's amortization schedule shows the exact split for every payment, so use it each month when recording the transaction.

3. Create sub-accounts for each debt instrument

When your company is carrying an SBA loan, a line of credit, and equipment financing simultaneously, a single "Interest Expense" line makes it nearly impossible to spot anomalies.

Create labeled sub-accounts under the parent interest expense account, such as "Interest, SBA 7(a)" and "Interest, notes payable." This speeds up reconciliation during month-end close and gives your CPA the details needed at tax time without a lengthy back-and-forth.

4. Accrue interest at period end on an accrual basis

If your company uses accrual-basis accounting and the interest payment date doesn't align with the month-end, both expenses and liabilities are likely understated until payment is made. Interest that has been incurred but not yet paid needs a journal entry at month-end: a debit to interest expense and a credit to interest payable.

Skipping this creates lumpy P&L swings, where months without a payment appear artificially profitable and payment months appear artificially expensive.

5. Track the interest coverage ratio quarterly

Many lenders embed coverage ratio covenants in your commercial loan agreements, and falling below the minimum can trigger loan acceleration or distribution restrictions. The interest coverage ratio, calculated as EBIT divided by interest expense, measures how comfortably your operating earnings cover debt service.

Tracking it quarterly lets you spot downward trends early, before a covenant breach becomes an urgent conversation your lender initiates.

How automation platforms help you manage interest expense and operating expenses

Despite these best practices, manual processes leave room for the same classification errors every close cycle. The right automation platform can reduce the most common ones and make month-end more consistent for your team.

Automating loan payment splits to avoid classification errors

Every month your company records a loan payment, someone has to reference the amortization schedule and manually split the transaction. If that step gets skipped, the full payment ends up in operating expenses.

Platforms that support recurring split-transaction rules can route the principal to the balance sheet and the interest to the correct non-operating account. Look for one that supports per-loan rule configuration and adjusts as the amortization schedule changes.

Catching misclassified interest charges before month-end reports

If someone on your team codes an interest charge to an operating expense category, the error won't surface on the P&L unless every transaction gets manually reviewed at close.

Spend management platforms with real-time categorization rules can flag transactions that don't match expected patterns and surface misclassified charges during the month rather than at close. Look for a platform that lets you set category-level rules by vendor or payment type.

Posting period-end interest accruals without manual journal entries

For companies on an accrual-basis accounting, month-end accruals for incurred but unpaid interest require a manual journal entry at each close cycle. When that entry gets missed, the P&L shows artificially high income in months without a payment.

Platforms with recurring journal entry templates can post these accruals automatically based on the loan schedule, keeping cash flow forecasts accurate and removing one more step from the close checklist.

Getting lender-ready reports with pre-separated cost categories

When finance teams manually separate operating and non-operating items each reporting period, the process introduces errors that require extra explanation in lender presentations.

Expense management software that connects to the general ledger can generate reports in which EBIT, EBITDA, and coverage ratios are already correctly separated. Look for a platform that produces investor-ready outputs without requiring a manual rebuild every quarter.

Frequently asked questions about interest expense and operating expenses

Why is interest expense not included in operating income?

Interest expense reflects how a business chooses to fund itself, not how efficiently it runs operations. GAAP places it below the operating income line so that EBIT measures core business performance independently of capital structure. Two companies with identical operations but different debt levels should show the same operating income, which is why the separation matters.

Can interest expense ever be capitalized instead of expensed?

Companies can capitalize interest under FASB ASC 835-20 when incurred during the construction or development of a long-term asset. In that case, it gets added to the asset's cost on the balance sheet rather than expensed immediately. This treatment applies only during active construction and stops once the asset is substantially complete.

What happens if I accidentally classify interest as an operating expense?

The full amount of the misclassified interest will understate your operating income and EBIT. Every metric built on EBIT inherits that error, including any coverage ratios lenders use for covenant compliance. Correcting it requires a journal entry to reclassify the amount, and if the error crosses reporting periods, prior statements may need to be restated.

Is business credit card interest also a non-operating expense?

Business credit card finance charges are generally recorded as interest expense, though their classification on the income statement isn't always explicitly mandated as non-operating. The underlying purchases are categorized by their nature (office supplies, travel, software), but the finance charge itself should be recorded to the interest expense account. Check with a CPA if the chart of accounts isn't set up to handle this correctly.

Are there IRS limits on deducting business interest expense?

Companies that meet the small business exemption under Section 163(j) can deduct business interest in full, subject to the applicable average annual gross receipts threshold. Businesses above that threshold face a cap that limits the deduction to 30% of adjusted taxable income. The exemption threshold updates annually for inflation, so verify the current limit with the IRS or a tax advisor before planning deductions.